Desun Real Estate Investment Services Group Co., Ltd.'s (HKG:2270) stock was strong after they recently reported robust earnings. We did some analysis and think that investors are missing some details hidden beneath the profit numbers.

Examining Cashflow Against Desun Real Estate Investment Services Group's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. The ratio shows us how much a company's profit exceeds its FCF.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to June 2024, Desun Real Estate Investment Services Group had an accrual ratio of 0.42. That means it didn't generate anywhere near enough free cash flow to match its profit. As a general rule, that bodes poorly for future profitability. In fact, it had free cash flow of CN¥4.5m in the last year, which was a lot less than its statutory profit of CN¥42.8m. Notably, Desun Real Estate Investment Services Group had negative free cash flow last year, so the CN¥4.5m it produced this year was a welcome improvement.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Desun Real Estate Investment Services Group.

Our Take On Desun Real Estate Investment Services Group's Profit Performance

As we discussed above, we think Desun Real Estate Investment Services Group's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Desun Real Estate Investment Services Group's underlying earnings power is lower than its statutory profit. The good news is that, its earnings per share increased by 71% in the last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you want to do dive deeper into Desun Real Estate Investment Services Group, you'd also look into what risks it is currently facing. In terms of investment risks, we've identified 1 warning sign with Desun Real Estate Investment Services Group, and understanding this should be part of your investment process.

This note has only looked at a single factor that sheds light on the nature of Desun Real Estate Investment Services Group's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.